LON:PAG | Paragon Group Plc (PAG) - A Model Of Excellence Is The Dictionary Definition!

29th Jul '15 by Dearg Doom

6 comments 9885 reads

Paragon of Companies (LON:PAG)
Market Cap 1.17 billion
Share Price £4.07

(I am a long term shareholder in this company for many years)

Re: Trading Statement Released Today

The group consists of three divisions

Paragon Mortgage
Idem Capital
Paragon Bank

Paragon Mortgages provide buy-to-let mortgages to landlords and residential property investors. Group-wide year-to-date buy-to-let completions totalled £816.5m (compared to £456.3 million in 2014) and (compared to £234.9 million in the same period in 2013). Some of the new mortgage originations are being completed by Paragon Bank itself.

Idem Capital seeks opportunities in the debt market. They buy debt (mortgages and unsecured assets) from other Banks and then try to recover it as much as possible. Little chance of forecasting future investment in this area. Only circa 20 million invested in first half and then 80 million in the last quarter. The company did indicate increase competition in this area, which probably means having to stump up more to buy the debt.

Paragon Bank Started in 2014. Has approx. £390 million in deposits. £200m extra deposited in last quarter. The company hopes to self-fund an increasing percentage of its own mortgage book in time. Car finance started last year is still in early stages of development. 12.6 million of loans originated to date.

Outlook

“The Group is well placed to generate further growth in each of its target markets” No real surprises or disappointments.

Forecasts

Low double digit p/e forecasted around 11 times. Growth in earnings expected for many years to come, given the inadequate supply of housing and the need for people to rent.

An Investment Viewpoint

The company had a severe liquidity issue back in 2008. The lessons learnt means I hope that steps are in place to avoid it happening again by having their own funding available from a variety of sources including its own new Paragon bank.
Paragon’s attractive cost structure (30%) is below the traditional big banks gives them an on-going competitive advantage in the more profitable bank lending areas.
Paragon does not get the same publicity as some of the other start up banks, and as a consequence tends to be off the radar for investors. Lower p/e as a result.
I like the company because it rewards shareholders with increasing dividends as well as the buyback of its own…

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underscored

29th Jul '15

Paragon are top of my list for short selling:

#1. Many large portfolio landlords have just been rendered insolvent by the budget.

#2. I expect that having identified current BTL as a potential risk to financial stability the BOE will as part of its' current review either remove or severely curtail IO lending to the sector.

#3. Basel III if implemented as is will lead to increased SVRs for commercial property lending.

#4. The failure of the UK house price bubble to mean revert, makes future mean reversion more likely not less, all it needs is a trigger, George Osborne and Mark Carney seem to have the will to squeeze. http://www.morningstar.com/cover/videocenter.aspx?id=705311

Rusty2

The main reason for the share price fall was because of budget buy to let tax changes. Aldermore have been hit also. I sold my holding in April. Lots of director selling in Feb/March.

Dearg Doom

Hi underscored,

Thank you for your thoughts. Yes you may be right in the long term. Sometimes, however government policy often has the opposite effect in the short term of what was intended.

I feel tenants will first feel the burden in looking for actual property to rent, caused by a slight reduction of number of houses available to rent, which leads on to direct or indirect rent increases to cover Landlords' additional cost.

The second wave will be felt on only a small percentage of Landlords. These Landlords will have to fund shortfall of income form other sources if necessary.

The third wave is the Lenders. They can protect themselves by the security given and the value of security given. Banks can also adjust interest rates charged to take account of increase risk of default among a group of borrowers.

Lets say house prices did fall 50%. Lenders would be rightly stuck and not fully covered on a percentage of their loan book. Lenders would have a liquidity problem in that if they took over all the default properties, it would depress the market confidence further. The Lenders would be slow to foreclose in that case. Cheap funding would be supplied to the Lenders to keep them going until disaster averted.

I don't think however we are anywhere near that time yet. There is also the matter of government intervention if such a scenario was to happen to reverse policies the government had initially put in place.

I realise that asset values are very much the beholder of market sentiment at any point in time. However a solution might be lending on rental cash flow rather than asset price securities for Landlords. This would help as a way of avoiding bad debts and putting house price movements to one side. Better for Paragon to lose market share at a certain point in the cycle than risk the entire business. As a shareholder I can sell independently of what Paragon do.

I will keep your points at the back of my mind for the time being and see how events unfold year to year. It is good to hear counter arguments. I don't short shares as it is far too difficult to time falls in shares especially on an industry basis.

Regards

Dearg Doom

Regards

Dearg Doom

BlueFrew

I agree with all 4 points in reply 1.

I'd also point out that the current tax treatment of BTL is a bit of an anomaly. We can't, as individuals, borrow money to buy shares and offset the interest payments against our dividend income. But anybody taking a BTL mortgage as an individual can currently offset interest payments against rents received.

I think that before too long anybody wanting to BTL will have a choice. Either borrow as an individual, but there will be no reliefs available. Alternatively run it as a business where tax reliefs will be available. However lending will be a lot tighter and interest rates are a lot higher, to reflect the fact that banks won't be able to raid the equity in the family home in the worst case scenario.

I think George Osborne probably realises that people in rented accommodation don't often vote Conservative. The demographics of the UK are interesting, in that there is a large number of people who are currently between the ages of 10 and 30. If GO has designs on leading the Conservatives into the 2025 election, I doubt he would want to do it with most 20-40 year olds in rented accommodation, with no little prospect of being able to afford their own home. I'm sure he's willing to risk the vote of a single landlord to try and gain the votes of multiple tenants.

So in the medium term I think the outlook for house prices is positive and they will fall significantly from current levels. I also think that their is more pain to come for highly leveraged landlords. I certainly wouldn't want to be holding shares in specialist BTL lenders at this moment in time.

Are you sure any money will be recovered by Paragon? In the case of the large portfolio's any recoverable may well be owed to HMRC. Sub-prime dumb money all over again. It seems some lenders learned nothing. https://drive.google.com/file/d/0B24wHuyDETj3SkdFSENqWE9HUDA/view?pli=1

30th Jul '15

http://moneyweek.com/how-george-osborne-could-kill-off-britains-buy-to-let-business/

Paragon Group Plc (PAG) - A model of excellence is the dictionary definition!

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Dearg Doom

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